Broker-dealers and advisors are both obliged to work in your best interest but in different ways. Learn about the regulatory differences between the two, as well as several key terms.
Broker-dealers and investment advisors can both play a crucial role in their clients’ financial lives, serving each investor’s specific situation and needs.
Although the terms sound similar, the two financial professionals actually operate under different rules and for different reasons. Everyday investors should understand the difference between broker-dealers and investment advisors, as well as several other common terms connected to these roles, so they can decide with confidence how their portfolio is handled.
Investment advisors, sometimes known wealth managers, are a person or firm that is engaged in the business of providing advice, making recommendations, issuing reports or furnishing analyses on securities for compensation.
The compensation is generally in the form of an advisory fee assessed as a percentage of the assets under management. For example, investment advisers work with clients to develop strategies and allocate investment portfolios to help clients purse their goals. Investment advisors may be ideal for investors who want someone else to manage their investments, or for investors who want assistance with planning for taxes, an estate, or a mortgage.
In contrast, a broker-dealers is a person or a firm that can buy and sell securities on its own account as well as on behalf of clients. They can recommend products that net them a commission, but an investor must approve each transaction. Technically, a broker is in the business of buying and selling securities on behalf of its clients, and a dealer buys and sells securities for its own account. A broker-dealer does both. Broker-dealers may appeal to investors who want to be more proactive in managing their own portfolios.
As a result of the different ways these professionals work, they abide by different legal standards. Investment advisors follow a “fiduciary standard,” while broker-dealers follow a “suitability standard” or “best interest standard.” Let’s take a look at these terms.
The following terms are used in these rules and may be important for investors to understand.
You may have seen these terms in recent financial news because the SEC has been revising the code of conduct for broker-dealers through new rules called Regulation Best Interest (Reg BI).
Beginning on June 30, 2020, brokers will be required to comply with the requirements of Reg BI when making recommendations to retail customers, including requiring a broker-dealer to act in the best interest of the customer when making a recommendation of any securities transaction or investment strategy involving securities.
In addition to adopting Reg BI, the SEC also clarified regulations on the conduct of investment advisors to “help retail investors better understand and compare the services offered and make an informed choice of the relationship best suited to their needs and circumstances.” Essentially, the idea is to add protection for consumers who are receiving recommendations.
With your own portfolio, you may find that you’d prefer to work with a broker-dealer over an investment advisor, or vice versa.
No matter which type of professional has a role in your financial life, it’s good to be aware of how they work and the rules they must follow as they buy securities for you. That way, you can be aware of any potential risks that could end up costing you extra money.
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